Should you pay extra on your mortgage?

You've probably dreamed of the day when you finally send in your last mortgage check and own your home free and clear.

Paying a little extra every month on your home loan is a way to make that dream a reality faster than you thought, and with today's historically low savings rates, it could make more sense than ever.

Rather than letting money languish in a CD, money market or savings account that pays practically nothing, many homeowners might be better served by paying down their mortgage.

Doing so can save tens of thousands of dollars in interest and shave years off your loan. Our accelerated mortgage payoff calculator can help you figure out how quickly you can pay off your loan and how much you'll save.

"It can be life-changing," says Jonathan Pond, a financial author and adviser from Newton, Massachusetts, who believes paying off your mortgage early can be one of the smartest moves you can make, especially as you reach retirement.

But before you start sending your spare cash to your mortgage company, you need to make sure your overall finances are in order. Paying extra on your home loan isn't always the smartest use of your money.

"We look at the whole picture when trying to make that decision," says Diane Pearson, a certified financial planner and shareholder at Legend Financial Advisors in Pittsburgh.

Pay Extra on a $200,000 Mortgage and Save Big

Example: 30-year loan, 4.0% rate

Extra payment

Time shaved off loan

Interest payment saved

$100

4 years, 11 months

$26,854

$200

8 years, 5 months

$44,929

$300

11 years

$58,009

Here are 3 things you must do before paying extra on your loan:

1. Pay off high-interest credit card debt.

With the average variable credit card interest rate around 16%, you'll save a lot more by paying down your card balances than by paying extra on a home loan that carries a 4% interest rate.

This is the first thing you need to decide before you even begin to hunt for a new place to live. No one wants to be house-poor, saddled with mortgage payments that gobble up too much of their paycheck. Follow these 5 smart moves, and you'll find the price range that fits your budget.

Even if your mortgage costs 4% or less, paying extra on that loan could be a better use of your money than letting it languish in low-paying CDs or savings accounts.

Economists Gene Amromin of the Federal Reserve Bank of Chicago and Jennifer Huang and Clemens Sialm of the University of Texas at Austin recommend a simple way to decide if that's true:

Multiply your mortgage interest rate by 1 minus your tax rate. If the result is higher than what you typically earn with a conservative investment, pay down your home loan. Otherwise, the savings option is better.

Whatever method you choose, paying off the mortgage could well reduce the amount of income you need in retirement by 20% or more, Pond says.

"Almost inevitably with a mortgage, there are going to be financial challenges," he says about the clients he's advised, "while those that retire without a mortgage pretty much have clear sailing ahead.